In the Budget unveiled on Thursday, Finance Minister Arun Jaitley proposed to increase the long-term capital gain tax on debt mutual funds from 10 per cent to 20 per cent. He also increased the minimum holding period for debt mutual funds to qualify for long-term capital gains tax to 36 months, from 12 months at present.
Debt mutual fund had enjoyed a tax advantage as compared to other financial products like bank fixed deposits. Debt fund holdings of more than a year attracted capital gains tax at 10 per cent or 20 per cent with indexation, whichever is lower. (Indexation implies adjusting the taxable income for the impact of inflation.)
On the other hand, interest earned on bank fixed deposits is taxed as per the investor's tax slab. This tax advantage of debt mutual funds made it a popular investment vehicle for corporates and high net-worth individuals who parked their excess cash in these instruments.
While announcing these changes to the taxation of debt mutual funds, Mr Jaitley said, the tax arbitrage opportunity in debt funds has "hardly benefitted retail investors as their percentage is very small among such mutual fund investors."
How the New Tax Proposal Works
According to the new tax rules on debt funds, the investor has to hold the funds for at least 36 months to qualify for the 20 per cent capital gains tax. If the debt mutual units are held for less than 36 months, it would be taxed according to the investor's tax slab. This brings debt funds at par with bank fixed deposits in terms of taxation, if it is held for less than 36 months.
The new tax proposals are also seen as a blow for the Rs 10 lakh crore Indian mutual fund industry. Debt funds comprise around 70 per cent of the total assets of mutual funds.
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